Question 2: Consider an economy with a single bank called the National Bank. Suppose the National...

Question 2: Consider an economy with a single bank called the National Bank. Suppose the National Bank has $500 in bank capital. Then assume the National Bank receives $1000 in deposits. It keeps 10 percent as reserves and loans the rest.

a) Show a T-account for the National Bank.

b) Calculate the leverage ratio.

c) Now suppose 20 percent of the borrowers defaulted. Can you show the new T-account?

d) What is the percentage decline in bank capital? What is the percentage decline in total assets? Why is the percentage decline in bank capital is larger than the percentage decline in total assets?

Solutions

Expert Solution

Ans. a) Show a T-account for the National Bank.

T-Accounts: National Bank
Liabilities	Amount	Asstes	Amout
Capital	$ 500.00	Reserve	$ 150.00
Deposit	$ 1,000.00	Loan	$ 1,350.00

	$ 1,500.00		$ 1,500.00

Ans. b) Calculate the leverage ratio.

Leverage Ratio= Total Debt / Total Capital

= 1000 / 500

= 2.00 times

Ans. c) Now suppose 20 percent of the borrowers defaulted. Can you show the new T-account?

T-Accounts: National Bank
Liabilities	Amount	Asstes	Amout
Capital	$ 230.00	Reserve	$ 150.00
Deposit	$ 1,000.00	Loan	$ 1,080.00

	$ 1,230.00		$ 1,230.00

Ans.d) What is the percentage decline in bank capital? What is the percentage decline in total assets? Why is the percentage decline in bank capital is larger than the percentage decline in total assets?

Percentage decline in bank capital= (500-230) / 500 = 54.00%

Percentage decline in total assets= (1500-1230) / 1500 = 18.00%

Percentage decline in bank capital is larger than the percentage decline in total assets, because 20 % defalut of borrower decrease capital only but no effect on deposit. As bank have to paid full amount which it's depositor deposit in bank, we can give loan default amount effect on capital only.

ekkarill92 answered 1 year ago

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